04/17/22 04:18 PM EDT

SUNDAY NIGHT REIT READ | 4.17.22 | (MPW)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Hope everyone enjoyed the long weekend!

Cartoon of the Weekend: Roll Over, Play Dead

Open Real-Time Alert (RTA) Positions:

4.11.22 - Sell Signal - Shorting WY $39.28 (LINK)

* Not a Position Monitor change, this is part of Hedgeye's risk management process.

Ticker: MPW

Subsector: Healthcare

Headline: Previewing the key points on our MPW Best Idea Short

Last week we added triple-net hospital REIT Medical Properties Trust, Inc. (MPW) to the Best Idea Short list. There is a lot here, none of it good.
First, what is absolutely clear to us is that the business is a non-economic roll-up of hospital assets delivering returns that in no way resemble triple-net lease economics. Leases struck with solid credit tenant quality, annual +2% rent escalators, 15-20+ years of term and no amendments should benefit from the power of compounding over time, and exhibit a cash yield-on-cost profile moving up and to the right with a positive second derivative. When charting MPW's profile as represented by cash NOI / Gross Real Estate, cash EBITDA / Total Gross Assets (to account for loans extended), pretty much any metric, the line is down and to the right over a decade.
In the meantime the balance sheet has doubled since 1Q19 to over $20 billion of assets, fueled by (1) nearly $4 billion of common equity raised via secondary offerings and ATM programs and (2) a nearly 2.5x turn increase in cash EBITDA leverage from 5.9x net debt / EBITDA to 8.2x as of 4Q21. It appears that the company used this capital to buy additional hospitals at increasingly long lease terms, which (1) extended the average lease maturity but also (2) increased the aggregate contractual dollar lease commitments and the amount of straight-line GAAP rent contributing to Core FFO which is a non-cash metric (more on that below). So to recap: (1) issue a lot of equity capital, (2) increase leverage meaningfully and (3) boost GAAP earnings while (4) cash returns deteriorate consistently over time. This begs the questions: what exactly are shareholders getting out of this arrangement and who benefits? Why should MPW have this cost of capital in the market? Also, why doesn't Ye Old Wall call this out? We would guess its because the banks are benefitting from raising all of that capital, but maybe we are just being cynical. Maybe its time for public investors to responsibly close the equity market to MPW, so as to effectively end what appears to be a shell game.
Concurrently MPW's largest operator, Steward Medical Group, which accounts for just under ~30% of MPW's pro forma rent thereby supporting the dividend payout and equity, is clearly under financial stress which is likely getting worse and in our view may be insolvent. MPW has questionable financial arrangements with Steward and has demonstrably extended loans, liquidity and equity capital to the company, presumably to help support Steward's rent payments back to MPW. MPW currently owns 9.9% of Steward outright and we believe is Steward's largest unsecured creditor. All in MPW has about ~$1 billion of "RIDEA" assets, which are essentially direct equity-like investments into its operators.
Thinking through that, that effectively may mean that MPW is not just the hospital landlord, rather owns and controls the hospital system both effectively today and under a bankruptcy scenario as the "fulcrum" position. We estimate that MPW currently trades at ~19-19.5x 2023E cash EBITDA adjusting for straight-line rent and other non-cash revenue. The best "blue-chip" publicly-traded healthcare system in HCA trades at just 9x forward EBITDA. Again thinking through this, 8-9x EBITDA is not that far away from MPW's current net leverage of over 8x on a cash basis.
The reader can see where we are going with this. On a stand-alone basis MPW is uneconomic and deserves a lower multiple / higher market-derived cost of capital which is likely to occur both organically and in a Quad 4. In a "worst case" downside scenario MPW's multiple blends down to a mix of real estate + operator, and this compression would lead to a massive loss in share value. There is a scenario, although perhaps taking longer to play out, where MPW has negative equity value.
One last point and getting back to the "who wins?" question. Management has paid themselves based partially on (1) non-cash "Core" or "Normalized" FFO and (2) at times the volume of acquisition activity. At the same time they have been selling stock with their hair on fire, selling over 90%+ of vested equity awards on our math over the last 5 years. It is easy to see the obvious conflict there, i.e. using the public entity's cost of capital to juice Core FFO over time and cash out. Whether intentioned or not those are the optics, and the underlying economics of the business are terrible and look nothing like a healthy triple-net REIT.
Short the stock and/or stay away. We would also suggest reading these points a couple times to let the circular arrangements sink in, as it is somewhat complicated when first exposed to it. More to come...